Ontario Teachers' Makes Grade With Private-Equity Plays

The name Ontario Teachers' Pension Plan hardly conjures an image of hard-nosed financiers working multibillion-dollar deals.

But in the increasingly influential world of private equity, the pension plan has joined the ranks of player, wheeling and dealing alongside some of the biggest names in the business and generating handsome returns on behalf of 158,000 of the Canadian province's public-school teachers whose retirement money it oversees. Ontario Teachers' Pension Plan, of Toronto, has invested five billion Canadian dollars (US$4.16 billion) of its C$85 billion fund in private equity, with most of that cash going directly into the companies that, like other private-equity players, it hopes to one day offer stock in or sell.

Plenty of large pension funds put some cash into private equity, but Ontario Teachers' is unusual in that it has a hand in most of its acquisitions rather than relying on outside private-equity funds. It employs 26 specialists to scout for prospective companies and even picks managers for some businesses it buys into. Ontario Teachers' employees also sit on the boards of some of these companies.

Joining up with New York private-equity heavyweight Kohlberg Kravis Roberts & Co., the fund completed two of the biggest buyouts in Canada's history -- the C$2.55 billion buyout of Canadian drugstore chain Shoppers Drug Mart in 2000 and the C$3 billion purchase of Canada's telephone directory Yellow Pages Group in 2002. This month, the pension fund teamed up with a Los Angeles firm, Ares Management LLC, to acquire National Bedding Co., maker of Serta brand mattresses, for an undisclosed amount.

"Ontario Teachers' has been on the leading edge of private-equity investment," said Janet Rabovsky, senior investment consultant in Toronto at Watson Wyatt Worldwide, a pension consultancy.

Other pension funds, including those in the U.S., are eyeing Ontario Teachers' lesson plan, looking for ways to improve their dwindling returns. Since the early 1990s, Ontario Teachers' private-equity portfolio has posted an annual return of more than 28%. According to Thomson Venture Economics, private-equity funds in the U.S. have posted average annual gains of 12.5% over the past decade, while U.S. buyout funds have notched just under 9% in average annual returns.

Ontario Teachers' results have other pensions interested in investing more in private equity, especially since their other, traditional investments are falling behind. "Private equity has been spared the malaise of capital markets," said Robert Bertram, who oversees all investments at Ontario Teachers'.

The Shoppers Drug deal, in particular, gets an "A" from private-equity watchers: Ontario Teachers' initially paid C$107.5 million for approximately 10% of Shoppers. Since taking the company public in 2001, the pension fund has reaped an estimated C$343 million, making nearly six times its money while retaining a large stake in the chain, which on paper is valued at about eight times as much as the pension plan originally paid.

Pensions around the world -- including Ontario Teachers' -- are struggling to maintain enough money to pay retirement benefits. Besides poor returns in the brunt of their portfolios, pensions are struggling with aging populations and more employees taking early retirement. In January, Ontario Teachers' disclosed a $19.4 billion funding gap, meaning that at that time its assets covered only 84% of its potential liabilities. That gap more than tripled from January 2004.

Among well-known pensions looking to see whether they can get more juice from private equity is the California Public Employees' Retirement System, or Calpers. The largest public pension plan in the U.S. has commissioned a strategic review of its Alternative Investment Management Program, which consists of private-equity and venture-capital investments and represents roughly 12% of Calpers's approximately $180 billion in assets. Since 1990, the unit has logged annualized returns of about 11%.

Direct investments in nonpublic companies account for slightly more than 2% of Calpers's entire "alternative-investment" portfolio, but that figure includes equity stakes Calpers has taken in well-known private-equity firms, such as Carlyle Group and Texas Pacific Group, in addition to investments in those firms' underlying funds.

Depending on their size and smarts, more pension plans may follow Ontario Teachers' and directly buy into private companies rather than through private-equity firms, which charge investors steep fees -- usually 2% of assets and 20% of profits each year.

Direct investments account for 75% of Ontario Teachers' private-equity portfolio, but the pension fund still uses local private-equity funds in new or unfamiliar markets. The fund recently plunged into Asia, divvying up nearly $400 million among Japan-focused Unison Capital; MBK Partners, a fund started by former Carlyle Group executive Michael Kim that will specialize in South Korea and Japan; and
J.P. Morgan Partners,
JPM 0.67%
which is raising a new pan-Asian fund.